Boulder Furniture has bonds outstanding that mature in 15 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,075. What is the company's aftertax cost of debt if its tax rate is 32 percent?

a. 3.58%

b. 5.53%

c. 5.21%

d. 2.97%

a. 3.58%

Explanation:

First, find the pretax cost of debt; the YTM.

You can solve this using a financial calculator. Input the following;

Maturity of the bond; N = 15

Face value; FV = 1,000

Price of the bond; PV = - 1,075

Recurring annual coupon payments; PMT = (6%) * 1000 = 60

Compute Semiannual interest rate; CPT I/Y = 5.264%

Therefore, the pretax cost of debt = 5.264%

Aftertax cost of debt = Pretax cost of debt (1-tax)

= 5.264% (1-0.32)

= 3.58%